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How are you measuring performance?

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In my book, The 8 Step Guide to Building a Social Workplace , I identify some of the levers organizations can use to encourage collaborative behaviours at work.  Measurement is fundamental to this, as it sends a clear message to employees about what the organization finds important, whilst at the same time giving strong feedback to employees on how they’re performing against those expectations.

It’s interesting therefore, to see a new study by Rice and Cornell Universities that shows the wide cross section of metrics currently used to measure executive performance, with social measures not ranking especially highly.

“On average, firms rely mostly on accounting-based performance measures, among which they put heavier weights on income measures, sales and accounting returns,” said David De Angelis, an assistant professor of finance at Rice’s Jones Graduate School of Business. “Our findings are in line with predictions from optimal contracting theories: Firms with complex activities and large growth opportunities tend to tie a larger fraction of the awards to market-based measures rather than to accounting-based measures.”

The study was prompted by new SEC rules requiring more disclosure on how organizations link compensation to performance.  The authors mined this new data to try and understand more how performance based pay was currently used throughout the corporate world.

They found that companies would typically link pay across several performance measures, with the majority linked to accounting based measures, a smaller amount linked to stock performance measures, and a very small minority linked to non-financial measures.

This trend towards market based measures was particularly pronounced in larger firms and/or firms that were regarded as having strong growth opportunities.  Accounting based measures were more popular in older, more mature industries.  In those high growth sectors, sales remained the key metric by which executives were measured.

“In growth firms, where CEO optimal actions are improving long-term growth opportunities, end-of-year accounting performance measures are likely to be less informative of optimal CEO actions,” the authors said. “For these firms, stock price performance, which captures investors’ perception regarding firms’ long-term growth opportunities, is a more informative measure.”

Two interesting findings from the study require further examination, the authors said. “First, a large portion of CEO awards is given at the discretion of the board. How exactly this portion of the awards is determined is an interesting topic for future research. Second, we find that CEO shareholdings have little association with the level of market-based awards in the CEO contract. This result is puzzling because we expect CEO shareholdings to act as a substitute to the market-based awards. We believe that further investigation of this result is another fruitful area for future research.”

This is particularly noteworthy given the high profile moves by some executives to adopt $1 remuneration packages in recent months.

“These CEOs are likely to own a large stake in the firm, so the incentives coming from the compensation are rather small compared with the incentives associated with their holdings,” De Angelis said. “This $1 salary tack could send a positive signal to the market, meaning the stock price might increase and potentially earn the CEO even more through their holdings.”

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